WHAT IS A 1031 EXCHANGE?
A 1031 Exchange is an excellent money saving tool for an investor. Normally when an owner sells their investment property, the property owner is taxed on any gain realized from the sale. However, through a Section 1031 Exchange, the tax on the gain is deferred until some future date. This tax-deferred exchange is an investment strategy that should be considered by anyone who owns investment real estate.
A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of “like-kind”, while deferring the payment of federal income taxes and some state taxes on the transaction
BENEFIT OF A 1031 EXCHANGE
The primary advantage of tax-deferred exchange is that the taxpayer may dispose of property without incurring any immediate tax liability. This allows the taxpayer to keep the Ã¬earning powerÃ® of the deferred tax dollars working for another investment. This does not mean that there will be no tax paid. To clarify; as long as the relinquished property is exchanged for a purchase of equal or greater value and a mortgage of equal or greater value then all the tax can be deferred, repeatedly. If the replacement property is of lesser value, than the investor pays tax only on the difference. If the taxpayer uses the net proceeds from the disposition of the property for anything except reinvesting in real property, they will owe tax at that time.
TYPES OF EXCHANGES
There are several different types of exchanges, here are two:
The Investor in the Delayed Exchange has up to 45 days from the date the relinquished property is transferred to identify the replacement property and 180 days to close escrow on the replacement property. They may also identify more than one property and close on more than one property or only close on one. A delayed exchange is the most common type of exchange.
The Reverse Exchange is more complex, and just the opposite of a delayed exchange. The investor acquires the replacement property first and then disposes of the original property.
REQUIREMENTS OF THE 1031 EXCHANGE
- Qualifying Property Any real property including but not limited to Vacant land, Condos/Town homes, Single Family Homes, Commercial Real Estate, New Construction, Vacation homes and even some Personal Property called “boot’ may qualify.
- Proper Purchase– Both the relinquished property and replacement property must be held for productive use in a trade or business or for investment. Property acquired for immediate resale will not qualify and the taxpayer’s personal residence will not qualify.
- Like Kind – Replacement property acquired in an exchange must be “like-kind” to the property being relinquished. All qualifying real property located in the United States is “like kind” and can be exchanged with any type of property. For example, land can be exchanged for a single family home; commercial property can be exchanged for land, and so forth.
- Exchange Requirement – The relinquished property must be exchanged for a property of equal or higher value, with same or higher mortgage amount, in order to defer all the tax. There will be some tax due if a replacement purchase is less value than the relinquished property. A qualified 1032 Intermediary must hold the proceeds from the first sale.
Deferred exchanges are facilitated by qualified Intermediaries that will assist the taxpayer in meeting the requirements of Section 1031. The investor will need to hire an Intermediary, as they may not personally receive any of the proceeds of the relinquished sale prior to the closing on the replacement property. A third party Intermediary must hold the proceeds of the relinquished property in an escrow account, and then credit the purchase of the replacement property. Costs for the exchange will vary from $750-$1500 or more depending on the complexity and number of properties in the exchange.
HOW WE CAN HELP
In order to do a proper exchange, specific wording must be written into the contract when you purchase and when you sell a property that you wish to use in a 1031 exchange. Buyers Broker of Florida understands 1031 Exchanges and can assist you in finding suitable exchange properties to meet exchange deadlines and find a qualified intermediary to handle all aspects of the real property exchange that results in a successful closing.